Simpler Taxes Now, Growth Later

WASHINGTON — As lawmakers consider rolling back many of the $1 trillion a year in tax breaks now doled out to businesses and individuals, some are promising that streamlining the tax code will not only raise revenue, but also spur economic growth.

But a number of prominent economists cautioned that, while cleaning up the code is a worthy goal, it would do little to stimulate the flagging economy.

The kinds of changes being discussed in the heated back-room negotiations between President Obama and the House speaker, John A. Boehner of Ohio — raising $800 billion to $1.6 trillion in additional tax revenue, along with significant down-the-road spending cuts — would most likely depress growth in the short term.

Longer term, economists said, streamlining the code might improve the allocation of capital enough to raise growth modestly. The overall economy might be 1 to 2.5 percent bigger than it otherwise would be after five or 10 years, translating into perhaps more than one million jobs.

While that growth would certainly be welcome, it falls far short of claims from some tax reform evangelists, who predict that adding certainty and simplicity to the tax code would by itself ignite an economic boom.

“This religious faith that a broader base gives you a better tax system and economy is overly optimistic and simplistic,” said Alan J. Auerbach, the director of the Robert D. Burch Center for Tax Policy and Public Finance at the University of California, Berkeley. “I think the benefits can be overstated.”

Economists from across the political spectrum concur that the nation’s complex tax code most likely hampers growth. Tax rates Americans pay are so uneven that they not only raise fairness issues, but also cause distortions in the economy, inducing financial decisions that individuals might not otherwise make, and might not be the most efficient use of capital.

Tax rates on different kinds of individual income vary by 20 percentage points. More than $1 trillion a year in breaks — as varied as a tiny effort to aid domestic makers of toy arrows and the huge exclusions for state and local taxes — riddle the code.

The cumulative effect of those loopholes, preferential rates and special programs distorts how investors invest, economists said. “You put money in less-productive investments,” said Joel B. Slemrod of the University of Michigan, summarizing the problem.

The bulk of economists agree in principle in the sensibility of “broadening the base” — or eliminating deductions and exclusions, to make more income taxable and allow for lower rates — to improve the overall investment climate.

Hypothetically, economists said, the growth effects of broad tax reform could be enormous. Huge overhauls, like replacing the income tax with a consumption or value-added tax, could increase economic output in the long run by as much as 9.4 percent.

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R. Glenn Hubbard is the dean of the Columbia Graduate School of Business and a top Republican economist.Credit
Carlo Allegri/Reuters

But a consumption tax has few supporters in Washington because many warn that it would be regressive, shifting too large a portion of the tax burden onto lower- and middle-income Americans. Moreover, few politicians think that Congress could agree on passing such a big reform.

In the scheme of things, economists said, the kinds of changes on the table in Washington are far too small to make much of a difference, meaning in the long run they might inject a meager-to-modest boost to growth.

“Nobody’s talking about reforms that big,” said R. Glenn Hubbard, the dean of the Columbia Graduate School of Business and a top Republican economist. “Limiting deductions to raise revenue? That’s not going to raise growth at all. And raising rates would hurt growth.”

“I’m not even sure that the academic literature on tax rates and growth maps well onto what people are talking about now.”

Several experts cautioned that changes to increase taxes on investment and savings income might hurt long-run growth, even if it improved the progressivity of the code.

“There are some tax subsidies that can be reduced with little effect,” said William McBride, chief economist at the Tax Foundation, an independent research group. But he believes that increasing taxes on capital gains and dividends — as the Obama administration is seeking to do — would “significantly slow economic growth” by shrinking the pool of money available for investment across the economy.

In the short term, policy experts expect that the combination of increased tax revenue and reduced government spending would put a drag on the economy. Both Democrats and Republicans have warned that too-steep tax increases or too-deep spending cuts might create a recession.

Nevertheless, a short-term “down payment” on a broader tax and entitlement reform process might sap growth in the next year or two. That so-called fiscal drag might be offset by increased business investment because of the removal of uncertainty, or a “relief rally” in the stock markets.

After that, any tax reform that significantly changed deductions, credits and breaks might cause economic disruption and even a little drag in the short term, economists said. But in the long term, a cleaner code that raised more money might rationalize investment decisions and aid growth, said many economists.

Besides, some economists said even small changes in macroeconomic figures could mean big changes in the lives of thousands of Americans. Edward D. Kleinbard, former director of the Congressional Joint Committee on Taxation, said that if eliminating tax expenditures did bring a one-half-percent increase in the annual pace of economic growth it would be a significant accomplishment.

“You’d be taking victory laps,” said Mr. Kleinbard, now a law professor at the University of Southern California. He said that the difference between economic growth of 3.5 percent and 3 percent a year means the economy would double in size in 21 years rather than 24. “It’s not earth-shattering, but it is meaningful, and there are very few things in the tax world that give you that kind of bend in the G.D.P. curve,” he said referring to the nation’s gross domestic product, or overall economic activity.

Moreover, economists point to another powerful benefit to getting the country’s debt under control: investors might feel more comfortable keeping their money in American bonds, American companies and American dollars down the road.

“There would be nothing better for the economy” than to get the debt under control in the long term, said Mark Zandi of Moody’s Analytics.

A version of this news analysis appears in print on December 1, 2012, on page B1 of the New York edition with the headline: Simpler Taxes Now, Growth Later. Order Reprints|Today's Paper|Subscribe